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Microfoundations of Two-sided Markets: The Payment Card Example

Author Info

  • James McAndrews
  • Zhu Wang

Abstract

This paper provides a theory of two-sided market dynamics with arguably better microfoundations. These alternative microfoundations focus on observable heterogeneities of both sides of the market in a competitive framework. The theory is rich in empirical predictions and is less dependent on a particular form of imperfect competition than other approaches. Our findings in the payment card example point to adoption costs and the distribution of consumer incomes and firm sizes as the key determinants of the shares of costs borne by each side. This result provides clear implications for industry dynamics and sheds light on the puzzle of asymmetric pricing.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 128.

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Date of creation: Jan 2007
Date of revision:
Handle: RePEc:dnb:dnbwpp:128
Contact details of provider: Postal: Postbus 98, 1000 AB Amsterdam
Web page: http://www.dnb.nl/en/

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Keywords: Technology Adoption; Two-sided Market; Asymmetric Pricing;

Other versions of this item:

Find related papers by JEL classification:
  • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
  • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
  • O30 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - General

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  1. Schwartz Marius & Vincent Daniel R., 2006. "The No Surcharge Rule and Card User Rebates: Vertical Control by a Payment Network," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-31, March.
  2. Rochet Jean-Charles & Tirole Jean, 2006. "Externalities and Regulation in Card Payment Systems," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-14, March.
  3. Mark Armstrong, 2005. "Competition in Two-Sided Markets," Industrial Organization 0505009, EconWPA.
  4. repec:rne:rneart:v:5:y:2006:i:1:p:71-102 is not listed on IDEAS
  5. Jovanovic, Boyan & MacDonald, Glenn M, 1994. "The Life Cycle of a Competitive Industry," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 322-47, April.
  6. Rochet Jean-Charles, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-28, June.
  7. Jean-Charles Rochet & Jean Tirole, 2007. "Must-Take Cards and the Tourist Test," DNB Working Papers 127, Netherlands Central Bank, Research Department.
  8. Fumiko Hayashi, 2004. "A puzzle of card payment pricing : why are merchants still accepting card payments?," Payments System Research Working Paper PSR WP 04-02, Federal Reserve Bank of Kansas City.
  9. Farrell Joseph, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-19, March.
  10. David S. Evans & Richard Schmalensee, 2005. "The economics of interchange fees and their regulation : an overview," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 73-120.
  11. Richard J. Sullivan & Zhu Wang, 2005. "Internet banking: an exploration in technology diffusion and impact," Payments System Research Working Paper PSR WP 05-05, Federal Reserve Bank of Kansas City.
  12. Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
  13. Weiner Stuart E. & Wright Julian, 2005. "Interchange Fees in Various Countries: Developments and Determinants," Review of Network Economics, De Gruyter, vol. 4(4), pages 1-34, December.
  14. Zhu Wang, 2006. "Learning, diffusion and the industry life cycle," Payments System Research Working Paper PSR WP 04-01, Federal Reserve Bank of Kansas City.
  15. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, 03.
  16. repec:reg:rpubli:105 is not listed on IDEAS
  17. Kevin J. Stiroh, 2002. "Information Technology and the U.S. Productivity Revival: What Do the Industry Data Say?," American Economic Review, American Economic Association, vol. 92(5), pages 1559-1576, December.
  18. Courchane, Marsha & Nickerson, David & Sullivan, Richard, 2002. "Investment in internet banking as a real option: theory and tests," Journal of Multinational Financial Management, Elsevier, vol. 12(4-5), pages 347-363.
  19. Comin, D. & Hobijn, B., 2004. "Cross-country technology adoption: making the theories face the facts," Journal of Monetary Economics, Elsevier, vol. 51(1), pages 39-83, January.
  20. Jean-Charles Rochet & Jean Tirole, 2002. "Cooperation Among Competitors: Some Economics Of Payment Card Associations," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 549-570, Winter.
  21. Rodolfo Manuelli & Ananth Seshadri, 2003. "Frictionless Technology Diffusion: The Case of Tractors," NBER Working Papers 9604, National Bureau of Economic Research, Inc.
  22. Richard J. Sullivan, 2000. "How has the adoption of Internet banking affected performance and risk in banks?," Financial Industry Perspectives, Federal Reserve Bank of Kansas City, issue Dec, pages 1-16.
  23. Allen N. Berger & Loretta J. Mester, 2002. "Explaining the dramatic changes in performance of U.S. banks: technological change, deregulation, and dynamic changes in competition," Working Papers 01-6, Federal Reserve Bank of Philadelphia.
  24. Sujit Chakravorti, 2003. "Theory of credit card networks: a survey of the literature," Payment Cards Center Discussion Paper 03-09, Federal Reserve Bank of Philadelphia.
  25. Zhu Wang, 2006. "Technology Innovation and Market Turbulence: A Dotcom Example," 2006 Meeting Papers 508, Society for Economic Dynamics.
  26. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  27. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
  28. Richard Sullivan, 2004. "Payment services and the evolution of Internet banking," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Aug.
  29. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
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Cited by:

  1. Krueger, Malte, 2009. "The Pricing of Payments," MPRA Paper 24759, University Library of Munich, Germany.
  2. Zhu Wang, 2008. "Market structure and credit card pricing: what drives the interchange?," Payments System Research Working Paper PSR WP 06-04, Federal Reserve Bank of Kansas City.
  3. Fumiko Hayashi, 2008. "The economics of payment card fee structure: what drives payment card rewards?," Research Working Paper RWP 08-07, Federal Reserve Bank of Kansas City.
  4. Antoine Martin & Michael Orlando, 2007. "Barriers to network-specific investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 705-728, October.
  5. Bolt, Wilko & Schmiedel, Heiko, 2009. "SEPA, efficiency, and payment card competition," Working Paper Series 1140, European Central Bank.
  6. Fumiko Hayashi, 2008. "The economics of payment card fee structure: what is the optimal balance between merchant fee and payment card rewards?," Research Working Paper RWP 08-06, Federal Reserve Bank of Kansas City.
  7. Fumiko Hayashi, 2008. "The economics of payment card fee structure: policy considerations of payment card rewards," Research Working Paper RWP 08-08, Federal Reserve Bank of Kansas City.
  8. Wilko Bolt & Sujit Chakravorti, 2008. "Economics of payment cards: a status report," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q IV, pages 15-27.
  9. Wilko Bolt & Sujit Chakravorti, 2008. "Consumer choice and merchant acceptance of payment media," Working Paper Series WP-08-11, Federal Reserve Bank of Chicago.

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